400% Increase in Property-Linked Loans Threatening China’s Banks: Fitch

China’s real estate industry may be showing signs of recovery this year, but the slumping sector still represents the single largest threat to the nation’s banks, according to an independent credit agency.

In a report examining risks facing China’s publicly listed banks Fitch Ratings found that residential mortgages and corporate loans backed by property have increased 400 percent since the end of 2008, compared with 260 percent for loans overall.

With the real estate sector still stuck in a year-long downturn, the US credit researcher raises concerns over the possible consequences should property values slide further.

The expansion in credit to the real estate sector is at least in part an intentional strategy by China’s central bank which is attempting to boost borrowing to combat slowing economic growth.

Is Property Collateral Raising Risks for China’s Banks?

Research by Fitch found that loans secured by property now make up 40 percent of total loans made by the listed Chinese banks which the agency covers. This number results at least in part by a tripling of residential mortgages in China since the end of 2008, and a five-fold increase in corporate loans secured by property during the same period.

In addition to loans to property developers, local government financing vehicles have also increased their borrowings during the past several years, with these loans typically backed by land assets. According to China’s Ministry of Finance borrowing by China’s provincial governments rose to RMB 16 trillion ($2.6 trillion) by the end of 2014, up 47 percent from June 2013.

The increase in property-backed loans, combined with shakiness in the property sector, may actually increase the chance of bank failure in China as dependence on the asset class as collateral exposes banks in the case of a rash of defaults or sector-wide downturn.

While Fitch believes that such a downturn is not a high probability, in a statement it warned that a protracted property slide could “force a chaotic deleveraging process for corporate borrowers,” which would threaten the stability of Chinese banks.

Loans to Property Sector Increasing

The increase in loans is largely intentional on the part of China’s banks, which have been instructed by the central authorities to make more cash available to help fight an economic slowdown.

China’s GDP growth slowed to 7.4 percent in 2014 and is projected to decline to 7.0 percent this year, due in part to lower activity in the real estate sector, which accounts for at least 15 percent of the nation’s economy.

On Sunday the People’s Bank of China ordered a quarter-percentage point reduction in interest rates, bringing the benchmark one-year loan rate to 5.1 percent, and the one-year deposit rate to 2.25 percent. The rate cut was the third such maneuver since November last year.

The property sector has also been the target of more specific stimulus measures, such as lowering of downpayment levels for buyers of additional homes. As a result RMB loans to the property sector ballooned to RMB 18.4 trillion ($3.02 trillion) by the end of March, up 19.4 percent compared to the same period in 2014.

In just the first quarter of this year lending to the real estate industry grew by RMB 994 billion, RMB 196 billion more than during the first quarter of 2014. In all, loans to the property sector accounted for 27 percent of total lending in the first three months of 2015, according to the central bank.